Liquidity – Why More is More and Non-Cash AlternativesPaul Winterowd
I made the plunge about a month ago – I became the proud owner of .027 Bitcoin and .885 Ether. If you’re doing the math, I took a whopping $1,000 and made my first foray into the world of cryptocurrency. It’s proven to be fortuitous timing if you’ve seen any news of late…
There have been a couple of bull runs in the cryptocurrency market over the last couple of years that have been hard to ignore, and there is certainly buzz right now.
So what gives? I thought we are laser focused on multifamily here???
Yes, yes we are. As a Capital Advisor and one who is constantly working with investors for source the best debt structure for their multifamily investments, a common qualification challenge investors face is that of not having enough cash and cash-like assets.
Real Estate isn’t a liquid asset. It moves slow and it is capital intensive. We also want to have our money deployed and working for us. If we hold on to cash in “high yield” savings accounts, we are losing money after inflation.
It’s a bad deal. Lenders want to see liquidity in order to lend, and investors/developers want to put their money to work.
And I get it, one of the biggest and most repeated arguments for investing in multifamily is to take money out of Wall Street and deploy it on Main Street. Many of us have been burned by Wall Street and fear the volatility. We can touch, see, and feel real estate, and we have control over how it is operated. Wall Street is completely out of our control.
I’ve been drinking the over-simplistic Kool-Aide for a while now that real estate is good and stocks and bonds are bad. But I thoroughly understand the value of liquidity for getting the best debt options. So, in an effort to avoid having capital sitting idle, I believe some diversification and exposure to liquid assets is worthy of a seat at the table of our portfolios.
The purpose of this article is to set forth options for multifamily investors to build up liquid assets that can generate a return on investment and keep them liquid for borrowing opportunities.
A liquid asset refers to cash or any other asset that can be easily converted to cash at or near its market value. A 40-unit apartment building may be worth $6 million, but in order to turn it into cash today, you may only be able to get $4.5 million – thus making it an illiquid asset.
All commercial lenders have liquidity requirements of the sponsor(s). There isn’t a universally applicable number, but a good rule of thumb to qualify is to have 10% of the loan amount in liquid assets after your equity injection.
I’ll take that a couple steps further. I recommend maintaining 10% of your net worth liquid. And for syndicators, I recommend 20%. Syndicators are pooling capital which allows them to do bigger deals, but liquidity can be a constraint to going bigger, so more is more when it comes to liquidity. Additionally – most syndicators partner on deals. You are an attractive partner when you bring liquidity to the table. This may really help you scale your business and grow your portfolio.
So, what do we do? It is a sound practice to have some cash-type assets to fall back on and to qualify for loans, but net negative growth our savings accounts are experiencing is hard to stomach. I’ve brainstormed some ideas of more productive ways to put your cash to work and generate a return.
Legal disclosure here is that I am not a licensed financial advisor and I still have a lot to learn about these options. I’m not offering investment advice, but rather starting a conversation and welcoming your feedback on what has worked for you and/or areas of cash management you are interested in.
High Yield Savings Accounts
That’s a bit of an oxymoron considering high-yield online savings accounts are paying somewhere in the range of .35% – .55%. At least it is better than your standard bank or credit union savings accounts. Still really losing ground when the Fed’s target annual inflation rate is 2%
Mutual Funds or ETF’s
Mutual Funds and ETFs provide wide exposure to the stock market and are easy to trade in and out of. The stock market has largely been on a bull run for the last several years and the returns have been there. It’s just a question of downside risk. It is a very passive, hands off strategy in that the fund manager does all the research and makes all the decisions.
There is a greater element of risk to just pick one or a few stocks. Where there is greater risk, there is also greater reward. Having done some trading myself, it is easy to fall in the trap of letting the losers run and selling the winners to take mild profits. Ideally, we do the opposite, take small losses on the losers and let the winners run. When this market falls, it falls fast and hard so precautionary measures such as stop-losses are a must.
A bond is a fixed income instrument that represents a loan made by an investor to a borrower – that borrower typically being a corporation or government entity. A bond includes the details of the loan and its payments. Bonds will have a coupon payment that becomes cash flow for the investor. One of the beauties of real estate is cash flow (passive income) so bonds can be another vehicle for generating consistent passive income.
Many corporate and government bonds are publicly traded thus making them liquid. Private notes or bonds that aren’t publicly traded would not be considered liquid assets.
Whole Life Insurance
There are a lot of folks that sell and promote whole life insurance policies to real estate investors. The whole life carries a “cash value” that builds over time. This cash value is accessible to the policy holder via a loan offered by the policy issuer. This loan doesn’t ever have to be paid back, but it does accrue interest to be paid to the policy issuer.
It can be appealing on some levels and not on others. Some people swear by these policies and others swear at them. It’s a fee heavy vehicle and it takes time to build that cash value up before it is material. I don’t believe there are universally applicable judgement calls for any investment and there are more polarizing pros and cons of whole life insurance.
From what I understand, it can be a good way to improve your liquidity position over long periods of time. I also understand you can limit downside risk with these policies and there are also some tax benefits so its worth exploring to see if it makes sense for your situation.
Back to the cryptocurrency conversation… A friend of mind described “investing” in cryptocurrency to a complete neophyte as “pure gambling” and investing in Altcoins as “gambling on gambling.” It provided me a good chuckle, primarily because of the candid truth in the observation.
There is a lot of buzz right now about this new asset class. My research tells me it isn’t going anywhere and there is a lot of promise in what it offers. Really could be the dawn of a new financial age. There are SO many unknowns that it is truly speculative. The volatility is daunting.
The way I see crypto is a bit of a lottery ticket. If you can stomach the short-term roller coaster, allocating at most a very small percentage (like 1-2%) of your net worth may turn out to be a lucrative gamble. It could also be less intelligent then burning your cash for heat in the winter. Time will tell…
Either way it is liquid and a way to increase your cash position while putting your money to work. That said – that piece of your portfolio could change by 50% in any given week. It’s not for the faint of heart, but kind of fun to talk about either way.
I love investing, and I love helping people optimize their investments through the debt options I offer to increase their leverage. As I put this article together and have pondered about this topic for the last few weeks, I’ve made a mental shift from a relatively binary perspective that the appropriate portfolio allocation was comprised of a little cash and a lot of multifamily.
There is room, and actual merit, in a more diversified approach and bolstering one’s liquidity by learning about and investing in vehicles that can provide cash flow, generate a return, and allow us multifamily folk the opportunity to buy more apartment building assets.
As always, I welcome your thoughts and feedback – let me know what you think because collectively we are better together.